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Good News for Chewy: Petco Says Customers Don't Mind Higher Prices

By Parkev Tatevosian, CFA – Dec 1, 2021 at 6:15AM

Key Points

  • Petco was able to offset rising input costs by passing them along to the customer.
  • That's because pet products are seen as essential in customers' eyes.
  • Chewy can potentially do the same, which could help its profit margin expand.

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Price increases typically result in customers buying fewer products.

Online pet retailer Chewy (CHWY 1.36%) got some good news from rival Petco (WOOF 1.70%) in November. Petco reported fiscal third-quarter earnings that showed healthy revenue growth. But that's not the only good sign Chewy got from its competitor's financial results.

The more significant news came from Petco's conference call following its earnings announcement. In the discussion, Petco's management highlighted that it raised prices on several of its products, and customers did not balk at the increases. Let's look at why that's good news for Chewy stock

A dog wearing a holiday costume.

Image source: Getty Images.

Customers respond relatively well to higher prices

Typically, when a company increases prices, consumers purchase less of a product. However, what is also important is the magnitude of that inverse relationship between prices and sales. Some products, usually non-essential ones, will see a more substantial decrease in sales when their prices go up. By contrast, basic things that people need every day -- such as food essentials -- experience a much smaller drop in sales when prices increase. These are known as "inelastic" products. 

So what happened in Petco's latest quarter? Like many other companies, it experienced rising input costs as a result of supply-chain disruptions. And so it faced the decision of whether to absorb those costs or pass them along to the customer by raising prices on its products. During the quarterly conference call, Petco CFO Brian LaRose discussed the approach his company has chosen in order to mitigate these inflationary pressures: 

"In regards to inflation, we have taken select pricing actions to offset cost input increases. Our pricing strategy has been executed methodically. And in aggregate, we've not seen any impact on units. We have an inelastic category and flexibility to adjust our pricing as dynamics in the market unfold."

In other words, Petco raised prices on some of its products, and consumers did not materially decrease the amounts they purchased.

Why it's good news for Chewy

Petco and Chewy sell similar products and are similarly sized when measured by revenue. In its most recent quarter ended Oct. 30, Petco boasted sales of $1.4 billion. In Chewy's fiscal second quarter ended Aug. 1, it achieved sales of $2.2 billion. Like Petco, Chewy is also facing rising input costs due to supply-chain challenges and higher marketing prices.

The latest product-pricing news from Petco could give Chewy more confidence to institute price increases of its own and expect customers to respond similarly. That will undoubtedly help the company maintain its impressive profit margin. From 2016 to 2021, Chewy's gross profit margin increased from 16.6% to 25.5%.

Good for investors in Chewy and Petco

Of course, the fact that Petco increased prices and did not lose much in customer orders is good for shareholders. Alternatively, both companies could have absorbed higher input costs rather than pass them along to customers -- and that might have decreased profit margins at both companies and made them less attractive investments. 

Parkev Tatevosian owns shares of Chewy, Inc. The Motley Fool owns shares of and recommends Chewy, Inc. The Motley Fool has a disclosure policy.

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